Category: Market Action

After CIBC’s earnings release this morning, Moody’s announced that it had:

affirmed the ratings of Canadian Imperial Bank of Commerce (CIBC) and rated subsidiaries and changed their rating outlooks to negative from stable. CIBC is rated B- for bank financial strength, Aa2 for long-term deposits, and P-1 for short-term obligations. This rating action follows CIBC’s earnings report for the fourth quarter of 2007 in which it disclosed details of a hedged portfolio of Collateralized Debt Obligations (CDO). 

The change in outlook is based on Moody’s view that this exposure highlights weaknesses in the firm’s strategic risk management. Moody’s concern centers on the concentration of counterparty risks to which it has exposed itself via a rapid and recent build-up of its CDO activities. Though Moody’s believes that any losses related to these particular exposures are manageable for CIBC, risk management weaknesses may expose the firm to further risks. Moody’s is also concerned that it has cited CIBC in the past for risk management weaknesses, and despite expected improvements, it now appears the bank has not fully addressed appropriate risk-taking at a senior, strategic level.

In other words … Moody’s is saying that CIBC got away with it this time, but they’ve been more lucky than smart.

In Super-Conduit/MLEC news, yet another bank is acting immediately:

Rabobank [RABN.UL] is taking the remaining assets of its structured investment vehicle (SIV) Tango Finance onto its balance sheet, the unlisted Dutch bank said on Thursday.

Rabobank, which manages Tango with Citigroup (C.N: Quote, Profile , Research), said the SIV has only 5.2 billion euros ($7.6 billion) in cash assets, down from 9.7 billion in July. Rabobank had warned on Wednesday that Tango’s size had almost halved as it has been selling off assets.

And the Northern Rock auction is running into trouble:

U.S. buyout firm J.C. Flowers’ offer to buy British bank Northern Rock (NRK.L: Quote, Profile , Research) was in doubt late on Thursday as people familiar with the matter said its interest had cooled.

J.C. Flowers remains interested in buying Northern Rock but is finding it increasingly difficult to meet the requirements of shareholders and the government, Bank of England and regulators, all of whom are involved in the auction, a person familiar with the matter said.
…
A consortium led by Virgin Group [VA.UL] has been picked as preferred bidder, but Flowers was considered its nearest challenger.

A consortium led by investment group Olivant is expected to submit a revised offer for the bank by Friday, sources have said.

And that’s all the colour for today! There wasn’t too much of interest anyway, other than the American Sub-Prime Plan, which has attracted considerable comment, not to mention buying.

But how about them PerpetualDiscounts, eh? Holy smokes … if they can keep up this performance every day for a couple of months, it’ll be a good year.

I didn’t understand it on the way down … I don’t understand it on the way up.

I feel reasonably confident when I say “on the way up”, because this looks just as much like a buying frenzy as anything else I’ve seen in the past … um … year, but who knows? Maybe everything will reverse itself tomorrow … and finding out is what makes it interesting to get up in the morning.

There were forty-eight other index-included $25.00-equivalent issues trading over 10,000 shares today.

I am fascinated by the unfolding story of the Florida State Board of Administration’s Money Market fund that I discussed on December 3. Bloomberg reports that the Executive Director has quit:

Coleman Stipanovich, the head of an agency managing a troubled $14 billion Florida investment pool for local governments, quit as officials approved a plan by BlackRock Inc. to salvage the fund.
…
Stipanovich, whose brother J.M. “Mac” Stipanovich is a Tallahassee lobbyist and Republican strategist who ran former Governor Jeb Bush’s campaign for governor in 1994, was appointed executive director of the state board in 2002.

In the late 1990s, Coleman Stipanovich worked as a lobbyist for PaineWebber Inc. in Florida and was paid $7,500 per month to help the firm win municipal bond business.

Stipanovich, a Vietnam veteran, has a master of science degree in criminal justice administration from Michigan State University and a bachelors of science in criminology from Florida State University.

Pretty impressive credentials for running an investment management firm with $184-billion under management, eh? There’s a small biography on the site:

As Executive Director of the State Board of Administration of Florida (SBA), Coleman Stipanovich serves as the Chief Investment Officer of the fifth largest pension fund in the United States. Total assets under management at the SBA are in excess of $150 billion, which includes the Florida Retirement System Pension Plan (Defined Benefit Trust Fund) and Investment Plan (Defined Contribution Trust Fund). Under broad authority granted by the Trustees, the Executive Director has administrative and investment authority and responsibility, within the statutory limitations and rules, to develop investment policies and tactically manage investments. The Trustees are Governor Charlie Crist, Chief Financial Officer Alex Sink, and Attorney General Bill McCollum.

But look at him:

 

Isn’t that just the kind of distinguished look that investment counsellors should all have? I haven’t been able to find any CV on the web that might possibly shed some light on why this man was considered suitable to run a large asset management firm – all I’ve found is a story about his 2002 appointment and a record of his reappointment. If anybody has information that might clarify the question of his qualifications, please share it.

But I suspect it’s just political patronage. Investment counsellors are all a bunch of overpaid yumps who, on average, perform averagely, right? So I suppose that since any idiot can do it and get paid extremely well while doing so, it doesn’t make any difference who you hire.

Just for comparison, let’s look at the CV of Jim Leech, CEO of Teachers.

Mr. Leech joined Teachers’ in 2001 to lead Teachers’ Private Capital and succeeded Claude Lamoureux as President and CEO in 2007.
…
Before joining Teachers’, Mr. Leech was President and CEO of Unicorp Canada Corp., one of Canada’s first public merchant banks, and Union Energy Inc., then one of North America’s largest integrated energy and pipeline companies.

Now, I don’t know Mr. Leech. I haven’t worked with him, I haven’t studied his career in detail, I haven’t even spoken to the man. But I have a lot of respect for Teachers’ and whether or not Mr. Leech is the perfect man for the job, it seems to me that this is the way public funds should be run … a guy with a solid CV runs a division for six years, THEN gets to be boss. Maybe that CV is in investment management, maybe it’s in some other industry … but it’s solid.

I last reviewed Prof. Stephen Cecchetti‘s series on subprime on November 28. Part 3 of the series, Why Central Banks should be Financial Supervisors talks about some countries’ separation of function that are elsewhere combined:

In places like Italy, the Netherlands, Portugal, the United States and New Zealand, the central bank supervises banks. By contrast, in Australia, the United Kingdom, and Japan, supervision is done by an independent authority.

He notes that Bernanke is an ardent supporter of combination:

[Bernanke Speech]  Its supervisory activities also allow the Fed to obtain useful information about the financial companies that do business with the banking organizations it supervises. For example, some large banks are heavily engaged in lending and providing various services to hedge funds and other private pools of capital. In the process of ensuring that banks prudently manage these counterparty relationships, Fed staff members, collaborating with their colleagues from other agencies, learn a great deal about the business practices, investment strategies, and emerging trends in this industry.

The other side of the coin is:

[Cecchetti essay] the most compelling rationale for separation is the potential for conflict of interest. The central bank will be hesitant to impose monetary restraint out of concern for the damage it might do to the banks it supervises. The central bank will protect banks rather than the public interest. Making banks look bad makes supervisors look bad. So, allowing banks to fail would affect the central banker/supervisor’s reputation.

In this same vein, Goodhart argues for separation based on the fact that the embarrassment of poor supervisory performance could damage the reputation of the central bank.

Cecchetti quotes an amusing example of the benefits of combination:

On 20 November 1988 a computer software error prevented the Bank of New York from keeping track of its US Treasury securities trading. For 90 minutes orders poured in and the bank made payments without having the funds as normal. But when it came time to deliver the bonds and collect from the buyers, the information had been erased from the system. By the end of the day, the Bank of New York had bought and failed to deliver so many securities that it was committed to paying out $23 billion that it did not have. The Federal Reserve, knowing from its up-to-date supervisory records that the bank was solvent, made an emergency $23 billion loan taking the entire bank as collateral and averting a systemic financial crisis. Importantly, only a supervisor was in a position to know that the Bank of New York’s need to borrow was legitimate and did not arise from fraud.
…
[note] At the time, computers could store only 32,000 transactions at a time. When more transactions arrived than the computer could handle, the software’s counter restarted at zero. Since the counter number was the key to where the trading information was stored, the information was effectively erased. Had all the original transactions been processed before the counter restarted, there would have been no problem.

(I should point out that computers, per se, are not to blame for the error – assuming that the malfunction happened as described, this was an example of poor programme management, design and testing as indicated in the main text, rather than a hardware error as implied in the note) … and then an example of the evils of separation …

Shortly after Bank of England Governor Mervyn King sent a letter to the Treasury Committee of the House of Commons,⁶ the U.K. Financial Services Authority made it known both that Northern Rock was on the verge of collapse, and that supervisors had known this for some time. Contrary to wide-spread perception of the position taken just a few days earlier in the Governor’s letter, the Bank of England was forced to make a substantial emergency loan, substantially tarnishing their public image.
…
I will say is that things surely would have gone more smoothly had the Bank of England had supervisory authority so that the officials with intimate knowledge of Northern Rock’s balance sheet would have been sitting at the table on a regular basis with the management of the central bank.

Cecchetti is very persuasive! The arguments make a lot of sense to me – but I’ll keep my eyes open for something from the other side. His fourth and final essay in the series, Does Well-Designed Monetary Policy Encourage Risk Taking, is not nearly as interesting – as far as I’m concerned he could have written finis after the first sentence:

Yes, but isn’t that what it’s supposed to do?

… but he had to fill it out a little. I have often argued in this blog that by way of policy objectives, what we want is a rock-solid, highly regulated banking sector, well insulated from the outer (much more fun) layer of innovation and speculation. He concludes:

Some observers worry that recent central bankers’ responses to the subprime crisis of 2007 will encourage asset managers to take on more risk than is in society’s interest. I believe that this is wrong. Punishment is being meted out to many of those whose risky behaviour led to the problems, while central banks’ actions have, so far, reduced the collateral damage that this crisis could have inflicted on the economy.

As far as the series is concerned, he has made the following four concrete proposals:

• Trust, but verify. Investors should insist that asset managers and underwriters start by disclosing both the detailed characteristics of what they are selling together with their costs and fees. This will allow us to know what we buy and understand our bankers’ incentives.
• Standardisation and trading. Governments could help clarify the relative riskiness of assets by fostering the standardization of securities and encouraging trading on organized exchanges.
• Deposit insurance. A well-designed, rules-based deposit insurance scheme is essential to protecting the banking system from future financial crises. Lender of last resort actions are no substitute for deposit insurance.
• Central banks should be financial regulators. Central banks should have a direct role in financial supervision. In times of financial crisis – as in times of war – good policy-making requires a single ‘general’ directing the operations.

Item 1 is not really a policy issue – it’s a matter for investors, their investees and their advisors. Just make sure people are, in fact, feeling some pain from bad decisions and not bailed out – that’s enough policy.

Item 2 – I argued against this on November 19. However, it may be that in ensuring the stability of the banking system, margin & capital requirements could well be raised to the point at which exchange-trading (and clearing houses with daily mark-to-markets) become competitive. However, an exchange cannot function in a thin market – which Mr. Cecchetti, I am sure, will say is addressed by his urging for increased standardization. By way of policy … make sure the banks are stable, ensure capital requirements are conservative, and let exchange trading and standardization look after themselves.

Item 3 – full agreement from me!

Item 4 – very persuasive arguments have been put forward, but I’ll reserve judgement until I hear more from the other side. I am confident that each example of the benefits of unification can be matched with an example of harm.

PerpetualDiscounts continued to rock-and-roll today, while floaters just rolled over and played dead. Sadly, there are only two issues in this sub-index, both BAM, so it’s very hard to determine just how much is due to credit concerns, how much is Floater concerns and how much is just random vagaries of the market. There was reasonably good volume, a reasonable number of trades, and a reasonable time between the decline of prices and the market close, so I’d have to say this move is as real as anything else.

But really, how about them PerpetualDiscounts? I KNOW it’s only three days into the month and a lot can happen, but let me enjoy it while I can, won’t you? It’s been a long year.

There were forty-five other index-included $25.00-equivalent issues trading over 10,000 shares today.

Wow! How about them PerpetualDiscounts, eh?

It figures. The Bank of Canada cuts rates and retail figures that means all rates, ignoring the fact that long Canadas were down on the day … lower rates means higher inflation risks, says the Market. Also ignoring the idea that corporate spreads tend to widen during tough times, since there is higher default risk.

Or maybe pref investors are saying that they know all that, it’s just that the whole thing since March has been overdone. Who knows? Ask a priest. I’m just glad to see the fifth straight trading day of PerpetualDiscount gains and that sub-index off its lows. But who knows what tomorrow will bring?

There were thirty-five other index-included $25.00-equivalent issues trading over 10,000 shares today.

Sorry – month-end is a busy time for me, so again, there’s not much colour today!

However, I was most interested in Accrued Interest’s essay on the implications of the Florida Money-Market Fund Freeze, together with the most recent Bloomberg story.

According to Bloomberg:

BlackRock, at a Tallahassee meeting today with officials from schools and cities in the Local Government Investment Pool, said it will recommend putting about 86 percent of the pool’s $14 billion of assets that have no risk of loss or default into a “fund A.” The remaining 14 percent will go into a “fund B,” said Simon Mendelson, chief operating officer of BlackRock’s cash management business.

“We want fund A to be really clean,” said Barbara Novick, vice chairman of BlackRock, who made the presentation with Mendelson. “We want to run it as a money-market fund.”

I don’t get it. When I look at the October 31 Holdings of the Florida fund, I don’t see 86% of the securities having “no risk of loss or defaults”. The only securities without default risk are central government securities denominated in the national currency (and their guarantees, if you want to be picky). Even then, “no risk” can be something of a relative term, as those who read about hyperinflation in the German Republic will remember:

The German Mark, the British shilling, the French franc, and the Italian lira all had about equal value, and all were exchanged four or five to the dollar. That was in 1914. In 1923, at the most fevered moment of the German hyperinflation, the exchange rate between the dollar and the Mark was one trillion Marks to one dollar, and a wheelbarrow full of money would not even buy a newspaper.

That was then and this is now, you say? I know a man with first-hand experience of Serbian hyperinflation:

In October of 1993 the created a new currency unit. One new dinar was worth one million of the old dinars. In effect, the government simply removed six zeroes from the paper money. This of course did not stop the inflation and between October 1, 1993 and January 24, 1995 prices increased by 5 quadrillion percent. This number is a 5 with 15 zeroes after it.
…
Many Yugoslavian businesses refused to take the Yugoslavian currency at all and the German Deutsche Mark effectively became the currency of Yugoslavia. But government organizations, government employees and pensioners still got paid in Yugoslavian dinars so there was still an active exchange in dinars. On November 12, 1993 the exchange rate was 1 DM = 1 million new dinars. By November 23 the exchange rate was 1 DM = 6.5 million new dinars and at the end of November it was 1 DM = 37 million new dinars. At the beginning of December the bus workers went on strike because their pay for two weeks was equivalent to only 4 DM when it cost a family of four 230 DM per month to live. By December 11th the exchange rate was 1 DM = 800 million and on December 15th it was 1 DM = 3.7 billion new dinars. The average daily rate of inflation was nearly 100 percent. When farmers selling in the free markets refused to sell food for Yugoslavian dinars the government closed down the free markets. On December 29 the exchange rate was 1 DM = 950 billion new dinars.
…
At the end of December the exchange rate was 1 DM = 3 trillion dinars and on January 4, 1994 it was 1 DM = 6 trillion dinars. On January 6th the government declared that the German Deutsche was an official currency of Yugoslavia. About this time the government announced a new new dinar which was equal to 1 billion of the old new dinars. This meant that the exchange rate was 1 DM = 6,000 new new dinars. By January 11 the exchange rate had reached a level of 1 DM = 80,000 new new dinars. On January 13th the rate was 1 DM = 700,000 new new dinars and six days later it was 1 DM = 10 million new new dinars.

So anyway, the moral of the story is: nothing is certain in this wicked world. There is default risk everywhere.

That being said, I find the holdings of the Florida fund rather surprising, in that (i) I don’t recognize a lot of the names held, and (ii) A lot of the names are of the form “XXX Funding LLC”. So, I’ll repeat, yet again, another moral we should all remember from the credit crunch: Diversify! Diversify! Diversify!

Without having had anything more than a casual once over of the Florida holdings, it seems to me that the managers were well diversified by name and tenor, but very poorly diversified by industry … I mean, geez, look at all those XXX Funding LLCs! You are not diversified if you have 1% of your portfolio in each of 100 different companies if each of those companies is in the business of manufacturing Britney Spears Fan Club kits.

As with Canadian ABCP – I have nothing but sympathy for portfolio managers who held 5-10% in the sector; it looked pretty good to me too, and (with the exception of Apsley Trust) the credit quality was fine – it was simply the liquidity that suddenly disappeared. But too much of a good thing is simply too much.

Accrued Interest‘s conclusions as to how the whole affair will play out look entirely reasonable to me … with one quibble:

Finally, government money market funds will likely become permanently more popular.

Permanently? I have my doubts. There have always been periodic flights to quality in the investment world, and sooner or later investor greed beats investor fear and competition forces the assumption of increased risk.

In sort-of related news on the MLEC/Super-Conduit front, Harrier Finance and Carrera Capital are being bailed out by their so-called off-balance-sheet sponsors, to the tune of $11-billion and $4.8 billion, respectively.

“Every day that goes by we are seeing more restructuring and liquidity provision by sponsors,” [Dresdner Kleinwort analyst Priya] Shah said in an interview today. “The longer M-LEC takes, the less of a need there will be for it.”

Another day of good volume and positive returns! Holy smokes, can this be the preferred market we’re looking at?

There were twenty-five other index-included $25.00-equivalent issues trading over 10,000 shares today.

An extremely busy day to finish the month!

There were seventy-four other index-included $25.00-equivalent issues trading over 10,000 shares today.

Well … today the TD Bank and National Bank financials were analyzed … and, in addition, month-end is a-coming and duty calls with a shrill, unpleasant voice.

So there won’t be much colour today.

American ABCP outstanding was down another $11-billion this week, continuing its decline as the overleveraged economy continues to unwind. Domestic Financial CP outstanding was up $25-billion; although this figure has not picked up all the slack since the peak, this illustrates the Banks Advantage in Cushioning Liquidity Shocks.

The Florida State-sponsored Money Market Fund mentioned yesterday has suspended redemptions:

Florida officials voted to suspend withdrawals from an investment fund for schools and local governments after redemptions sparked by downgrades of debt held in the portfolio reduced assets by 44 percent.
…
It wasn’t decided how long the suspension would last. The trustees meet again on Dec. 4.

“We’re getting a lot of calls,” said Mike McCauley, the spokesman for the State Board of Administration.

The Florida pool crisis is a sign of poor risk management by state officials, said Harvey Pitt, former chairman of the Securities and Exchange Commission.

“In the longer-term, it’s unlikely that those whose funds have been frozen will leave their money in the investment fund once the freeze lifts,” Pitt said. “All of this could, and should, have been avoided by careful due diligence, constant reassessment of risk, and paying close attention to market trends.”

Mr. Pitt did not disclose his own track-record as a money manager. His criticisms are the kind that really drive me wild – post-hoc criticisms of fund managers by guys who’ve never done it. It’s very easy to be wise after the fact.

The big danger is that such public funds will eventually migrate to nothing riskier than three-month T-Bills; why would a trustee allow anything else if he’s going to be vilified whenever he’s wrong on something?

One can only applaud Henri-Paul Rousseau in his testimony to the Quebec legislature’s public finance committee:

Executives of Canada’s biggest pension fund agreed after careful study that what constituted a crisis was open to interpretation, but believed the financial institutions would honour their commitments, he said under questioning at the provincial legislature’s public finance committee.

“There was some thinking out there that this was very risky,” Mr. Rousseau said. “We thought it was not plausible and it happened. That’s it.”
…
“Were we prudent? Yes. Did we miscalculate in terms of the probability that this would happen? Yes,” he said. “Unfortunately, that happens in our business.”

Way to go, M. Rousseau! I have no idea whether you’re a good or bad manager, either of people or of money, but at least you know the right things to say – and on this occasion, when things have gone wrong, you’re willing to wear it. My own question is, regardless of whether or not it was prudent to have $13-billion out of total Caisse assets of $207-billion in Canadian ABCP, was it prudent to have $13-billion in a $35-billion asset class? M. Rousseau’s full remarks have been published by the Caisse. He points out that while liquidity is a problem, the credit quality is entirely acceptable. I will confess that I haven’t even checked to see what proportion of the entire Money Market portfolio was comprised of ABCP, or what the investment rationale behind the MM allocation might have been.

The US bond market is on fire, with a buying panic and lots of corporate issuance; Bernanke seems to be guiding the market to expect an ease.

Another day of good volume for preferreds, with some evidence of rationalization of prices, although overall performance wasn’t all that great. Split shares had a great day, but are still basically clobbered on the month, while floaters are getting hit … trouble is, it’s hard to separate the company specifics (BAM & BCE) from the asset types. Still, that’s what makes it fun, right?

There were forty-one other index-included $25.00-equivalent issues trading over 10,000 shares today.

Arthur Levitt brought his travelling anti-Credit Rating Agency roadshow to Toronto yesterday, giving a speech at the 2007 Dialogue with the OSC. The Globe has a video of his remarks; they were reported as the same old same old:

Credit rating agencies have lost the trust of investors following the recent meltdown in commercial paper markets, leading to a “systemic shock” in capital markets, a former chairman of the U.S. Securities and Exchange Commission said yesterday.

Arthur Levitt, who led the SEC between 1993 and 2001, told an Ontario Securities Commission conference yesterday the rating agencies are deeply conflicted because they take money from companies to rate their securities, and also offer them consulting services.

“The agencies have become both coach and referee,” he said. “Indeed, I believe we’re facing the prospect of a systemic shock directly as a result of investors’ loss of confidence in the ratings that they have relied upon for so long to evaluate risk.”

He said regulators must examine the conflicts of interest that “plague” rating agencies. Beyond simply prohibiting them from doing additional consulting work for companies they rate, he said the SEC should be given more authority to regulate agencies.

Well, fine. Levitt believes the agencies have lost the trust of investors. My first question is “Where’s the evidence?” and my second is “So what?”. There are plenty of shops around, well staffed and just aching to sell a subscription to their services to anybody who wants to pony up the cash. Unless, of course, having decided that the agencies screwed up, the regulators want to start awarding and yanking licenses on the basis of track record …

David Wilson, Chair of the OSC, mentioned them briefly in his published remarks:

And, we’re talking with credit rating agencies that do business in Canada.
Global securities regulators are carefully reviewing:
• the use of credit ratings in regulated instruments;
• the conflicts inherent in the rating process for structured products; and
• the transparency of the assets held and leverage embedded in these structured product vehicles.

Wilson’s remarks are reasonable enough (a regulator should certainly have some vague idea of what’s happening in capital markets!), but the fact that they invited Levitt to speak at their showcase event is more than just a little odd. 

It’s worrisome. Same old story. If there’s one thing that drives a regulator crazy, it’s the thought that somebody, somewhere, is not filling out a form. To address this issue, the agencies should hire some staff away from the regulators at, say, $200,000 p.a. + benefits, and get some of that good old revolving door regulation going – just like RS is so proud of.

Perhaps I’m feeling a little grumpy today, but I didn’t really see anything new and interesting in a Financial Times essay on the credit crunch referenced by Naked Capitalism. There was an interesting graphic, though:

Note that the sawtooth pattern for the Euribor rate is due to anticipation of well-telegraphed policy increases.

There’s more on the story about the Florida government money-market funds, which were briefly mentioned on November 14 (with friend Levitt labelling them “disgraceful”). Clients are pulling out their money:

Florida local governments and school districts pulled $8 billion out of a state-run investment pool, or 30 percent of its assets, after learning that the money- market fund contained more than $700 million of defaulted debt.
…
The Florida pool, which was the largest of its kind in the U.S. at $27 billion before the recent spate of withdrawals, has invested $2 billion in SIVs and other subprime-tainted debt, state records show. Connecticut, Maine, Montana and King County, Washington, are among other governments holding similar investments, in smaller quantities.

The Florida pool’s $900 million of defaulted asset-backed commercial paper now amounts to almost 5 percent of its holdings. The paper, which carried top ratings from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings as recently as August, was downgraded after declines in the value of collateral affected by the subprime mortgage slump.

I’ve had a look at the State Board’s 2005-06 Investment Report, an extremely glossy puff-piece with little worthwhile investment reporting, but there is a description of the fund in question.

When local governments in Florida have surplus funds to invest, they often rely on the Local Government Investment Pool (LGIP). As a money market fund, the LGIP invests in short-term, highquality money market instruments issued by financial institutions, non-financial corporations, the U.S. government and federal agencies. In managing the pool, the SBA strives to maximize returns on invested surplus funds to generate revenue that helps local governments
reduce the need to impose additional taxes.

It will be most interesting to see how this pans out!

There was some bad news on the US Housing front brought to us via a National Association of Realtors press release:

Single-family home sales were unchanged from September at the seasonally adjusted annual rate of 4.37 million in October, and are 20.8 percent below 5.52 million-unit level in October 2006.  The median existing single-family home price was $205,700 in October, down 6.3 percent from a year ago.

Existing condominium and co-op sales fell 9.1 percent to a seasonally adjusted annual rate of 600,000 units in October from 660,000 in September, but are 20.2 percent below the 752,000-unit pace in October 2006.  The median existing condo price4 was $223,500 in October, up 4.9 percent from a year ago.

The month/month figures is just noise; it’s the year/year statistics that look worrisome. The Wall Street Journal prepared a graphic of inventory:

I love the handy little arrow they added, to ensure we didn’t look at the chart upside-down or something. They also provided a round-up of commentary.

Prof. Stephen Cecchetti continued his VoxEU series today, which commenced on November 26. He concludes:

So, here’s the problem: discount lending requires discretionary evaluations based on incomplete information during a crisis. Deposit insurance is a set of pre-announced rules. The lesson I take away from this is that if you want to stop bank runs – and I think we all do – rules are better.

This all leads us to thinking more carefully about how to design deposit insurance. Here, we have quite a bit of experience. As is always the case, the details matter and not all schemes are created equal. A successful deposit-insurance system – one that insulates a commercial bank’s retail customers from financial crisis – has a number of essential elements. Prime among them is the ability of supervisors to close preemptively an institution prior to insolvency. This is what, in the United States, is called ‘prompt corrective action,” and it is part of the detailed regulatory and supervisory apparatus that must accompany deposit insurance.

In addition to this, there is a need for quick resolution that leaves depositors unaffected. Furthermore, since deposit insurance is about keeping depositors from withdrawing their balances, there must be a mechanism whereby institutions can be closed in a way that depositors do not notice. At its peak, during the clean-up of the US savings and loan crisis, American authorities were closing depository institutions at a rate in excess of 2 per working day – and they were doing it without any disruption to individuals’ access to their deposit balances.

Returning to my conclusion, I will reiterate that the current episode makes clear that a well-designed rules-based deposit insurance scheme should be the first step in protecting the banking system from future financial crises.

I quite agree with him. The Northern Rock episode – discussed in the context of deposit insurance on October 18, shows that politicians – and, by contagion, government sponsored departments – have squandered the trust placed in them. There have been too many broken promises, too many excuses. Additionally, it is completely unreasonable to expect small retail depositors to monitor the health of their friendly neighborhood bank, particularly at the height of a crisis. Banks should be supported by government sponsored deposit insurance as a social good; in exchange, they must pay insurance premiums based on their risk and submit to regulation of their capital adequacy.

The recent crisis is showing us that there is some cause for concern that this inner fortress of stability may not have been insulated enough from the outer, much less regulated, ring of the general capital markets; but I feel confident that the gnomes of Basel will be reviewing their stress tests over the next few years to account for new ways around the rules. As I mentioned on October 3, guarantees of liquidity and credit, particularly, need to be charged to risk-weighted assets at a higher rate. The default assumption must be that if the bank’s name is on a product – or if the bank is profitting from the product’s existence – then the risk of the product should be consolidated onto the bank’s books.

People invest in these things because of the banks’ reputations. The bank has a good name due largely due to regulation and deposit insurance. When – not if – a product fails, the banks’ reputation is harmed. Therefore, regulation should not pretend that there is no risk to capital from an off balance sheet sponsored product.

VoxEU also published an interesting paper on capital integration within the EU by Sørensen and Kalemli-Ozcan. Essentially, the authors argue that capital markets in the EU are, at least to a certain extent, balkanized, with saving regions refusing to invest in growing regions due to lack of trust.

Our findings suggest that Europe has a long way to go before its capital markets are as integrated as the U.S. market is internally. However, our work also suggests that much of the fragmentation stems from things that the EU cannot directly affect in the short run. Trust and confidence are things that evolve slowly. Policies that reward transparency and punish corruption may help but this is likely to take generations as exemplified by the low level of confidence in East Germany.

Good volume today – and at least some of the completely wierd prices that have become normal lately are starting to rationalize. I just hope there weren’t any Assiduous Readers waiting for the bottom on BNA.PR.C … but on the other hand, I don’t know where it’s going to open tomorrow. One shot wonder, or trend-reversal? Place yer bets, gents, place yer bets…

There were thirty-five other index-included $25.00-equivalent issues trading over 10,000 shares today.

Update: cowboylutrell in the comments points out I screwed up the asset coverage for FTU.PR.A in the ‘Price Changes’ table. It has been corrected. Sorry!

Of most interest today (well … last night!) was the Abu-Dhabi SWF investment in Citigroup. As noted by Naked Capitalism, this deal was done, effectively, at a concession to the current market price, given that the preferreds are protected against a dividend cut on the common, have a dividend yield that is greatly in excess of the common yield, and convert to common at prices not all that much in excess of current prices in a few years’ time. The concession has not escaped notice:

The deal may dilute the value of Citigroup’s stock, reducing 2008 earnings by as much as 20 cents a share, Bank of America analyst John McDonald estimated.

Citigroup shareholders are “ultimately the ones who are paying,” said William Smith, chief executive officer of Smith Asset Management in New York, which oversees $80 million, including about 70,000 Citigroup shares. “If you look at 11 percent, that’s basically junk bond yields, and so it’s great for Abu Dhabi.”

However, the deal will reinforce Citigroup’s capital ratios and that’s what counts. A bad capital ratio could mean no profits to be diluted! Freddie Mac is also selling prefs at concessionary prices:

Freddie Mac, the second-biggest source of money for U.S. home loans, plans to sell $6 billion in preferred stock and cut its dividend in half to shore up capital depleted by record mortgage defaults and foreclosures.

The two-part sale will include non-convertible, non- cumulative preferred stock and a “substantially smaller” portion of convertible preferred shares, Freddie Mac said in a statement today.
…
Freddie Mac sold $500 million of preferred shares in September with a fixed dividend rate of 6.55 percent. The shares, issued at $25 each, were trading at about $20 today.

Those who are familiar with the rules for Tier 1 bank capital will be most amused by the following bizarre attempt to create a controversy (hat tip: Financial Webring Forum):

When either Freddie or Fannie attempt to build capital, they are handicapped by a peculiarity that very few investors know about: They cannot sell the most popular kind of preferred stock, the “cumulative” variety, because their regulator will not let these securities count toward capital.

What “cumulative” signifies in this context is that if dividends are missed, they pile up to be paid on some brighter day, if that arrives. To the extent that Freddie and Fannie issue preferred shares, therefore, they are forced into selling the “non-cumulative” variety. That means if a dividend is missed, say, in the first quarter of 2008, the owners of the preferred will never get that dividend. It’s just gone, zip!

Naturally, prudent investors are not wild about owning non-cumulative preferred shares, which is why there are not many of these securities around. What smart investor unnecessarily wants to put himself in the position – no matter how remote – of missing a dividend and never thereafter being able to capture it?

Note that Quantum Online lists 144 non-cumulative US issues. Cumulative issues are very nice to have, but they don’t count as Tier 1 Capital for banks. OFHEO is to be applauded for disallowing the inclusion of such issues in capital.

These deals, I think, may be classed in the same category as GWO’s sale of its US healthcare business, in that what is going on – once all the frippery is tossed aside, is a conversion of debt into equity. Lord knows what Abu-Dhabi has had its money invested in until now – I mentioned the transparency issue briefly on September 24 – but there is no reason why it can’t have been a savings account at Citigroup, which is now, as far as they’re concerned, moving up the ladder to become equity; with no effect on Citigroup’s cash, but salutary effects on their ratios.

GWO  is using the proceeds of their sale to repay the bridge debt on their purchase of Putnam, instead of selling term debt to finance this. Even if the buyer, Cigna, finances through debt it will be term debt from a strategic buyer.

There is another very similar – in its essentials – situation occuring in the SIV area. MBIA and its problems in finding financing for its conduit, Hudson-Thames was mentioned here on October 25. Now we learn that:

MBIA Inc., the largest bond insurer, is winding down its structured investment vehicle after failing to find buyers for the SIV’s short-term debt since August, Chief Financial Officer Chuck Chaplin said.

MBIA has shrunk its Hudson Thames Capital SIV to about $400 million from $2 billion through asset sales to bondholders, Chaplin said. The Armonk, New York-based company has taken an “impairment” on its own $15.8 million equity stake, Chaplin told a conference hosted by Bank of America Corp. in New York today.
…
MBIA asked holders of the lowest ranking bonds of Hudson Thames, known as capital notes, to buy a share of the SIV’s bank bonds, asset-backed securities and other holdings in proportion to the amount of debt they own.

The so-called “vertical slice” deals enable SIVs to raise cash while bondholders avoid the risk of their investment being wiped out in a fire sale, Fitch said in a report this month.

And this is how the credit crunch will be resolved. Equity holders will take their lumps; debt holders will move up the risk-return ladder at concessionary prices; and the indigestible debt will slowly, but as inexorably as the ticking of a clock, be run off the books.

I think.

There is shock and horror all over the place with the release of the Case-Shiller US Housing Price Index for September:

“The declines in the national figure are notable for two reasons,” says Robert J. Shiller, Chief Economist at MacroMarkets LLC. “First, the 3rd quarter decline, at 1.7%, was the largest quarterly decline in the index’s 21-year history. And, second, the year-over-year decline posted its second consecutive record low at -4.5%. Consistent with prior 2007 reports, there is no real positive news in today’s data. Most of the metro areas continue to show declining or decelerating returns on both an annual and monthly basis. All 20 metro areas were in decline in September over August. Even the five metro areas that still have positive annual growth rates — Atlanta, Charlotte, Dallas, Portland and Seattle — show continued deceleration in returns.”

Appallingly, the annualized internal rate of return for the indices since their base-date of January 2000 is a mere 9.15%. There’s a great post at the Irvine Housing Blog (hat tip: WSJ) about the loan history of a Very Nice House:

The property was purchased in January 2005 for $1,157,000. The combined first and second mortgages totalled $1,156,730 leaving a downpayment of $270. Let’s just call it 100% financing.

By April, they owners were able to find refinancing through Countrywide with a $999,999 first mortgage. This mortgage was an Option ARM with a 1% teaser rate. The minimum payment would be $3,216 per month.

Also in April of 2005, they took out a simultaneous second mortgage for $215,000 pulling out their first $58,000.

So look at their situation: They are living in a million dollar plus home in Turtle Ridge making payments less than those renting, and they “made” $58,000 in their first 4 months of ownership.

Apparently, these owners liked how hard their house was working for them, so they opened a revolving line of credit (HELOC) in August 2005 for $293,000. Did they spend it all? I can’t be sure, but the following certainly suggests they did.

In December of 2005, they extended their HELOC to $397,990.

In June of 2006, they extended their HELOC to $485,000.

In April of 2007, the well ran dry as they did their final HELOC of $491,000. I bet they were pissed when they couldn’t get more money.

So by April 2007, they have a first mortgage (Option ARM with a 1% teaser rate) for $999,999, and a HELOC for $491,000. These owners pulled $333,000 in HELOC money to fuel consumer spending.

Assuming they spent the entire HELOC (does anyone think they didn’t?), and assuming the negative amortization on the first mortgage has increased the loan balance, the total debt on the property exceeds $1,500,000. The asking price of $1,249,000 does not look like a rollback, but if the property actually sells at this price, the lender on the HELOC (Washington Mutual) will lose over $300,000.

Speculation about the forthcoming Fed meeting is ramping up, with Goldman calling for 150bp easing by the second quarter, but … what are the implications for inflation?

So far, inflation expectations have remained stable. Yet I consider those expectations more fragile now than I did four to six months ago. The rise in oil prices and the simultaneous increases in a broader basket of commodity prices suggest that significant inflationary pressures exist in the economy and thus the Fed must be very vigilant. If inflationary expectations rise, it could prove very costly to put the genie back in the bottle.

Very good volume in the pref market today, but performance continued to be (i) Weird and (ii) Poor. Splitshares bounced back (despite their expulsion from the S&P/TSX index), but that was more of a dead cat kind of thing than anything else – although it is rather pleasant to say that WFS.PR.A closed at 9.70-79, 121x10.

The PerpetualDiscount index broke below the 900-mark, setting yet another new low. But with all this volume, things must rationalize soon … mustn’t they?

 

There were forty-eight other index-included $25.00-equivalent issues trading over 10,000 shares today.

The big news today was Quebecor World’s suspension of preferred dividends; but that has its own post.

There was a fair bit of news on the MLEC/Super-conduit front. HSBC is bailing out its SIVs, taking $35-45-billion onto its balance sheet to avoid a fire-sale of the assets. It has been reported:

The SuperSIV is “is all good and well, but it’s not big enough,” said Tom Jenkins, a credit analyst at Royal Bank of Scotland Group Plc in London. “If you have a large SIV, you’re going to need to find another solution.”
…
Cullinan’s net asset value, the amount left over after selling all its assets and repaying debt, fell to 69 percent of its capital, Moody’s Investors Service said Nov. 7. Asscher’s net asset value has declined to 71 percent, Moody’s said.
…
HSBC plans to make a formal offer to investors in the SIVs’ lower-ranking mezzanine and income notes later this year or early 2008. It expects to complete the restructuring by August 2008.
…
“HSBC believes there is not likely to be a near-term resolution of the funding problems faced by the SIV sector,” the bank said.

It will be most interesting to see what kind of bid the capital noteholders will see – I bet HSBC sticks it to them!

Meanwhile, there is a report that marketting of the Super-Conduit is about to commence in earnest … but one can detect a certain jeering tone in the commentary:

“Why should we put something on our balance sheet that is going to result in further writedowns?” is how most contributors will respond, [Punk Ziegel & Co. analyst Richard] Bove said in an interview. “The job of the Treasury isn’t to go out and defraud investors.”
…
Bank of America “has far more to gain down the road” with regulators by backing SuperSIV, said Tony Plath, a financial professor at the University of North Carolina at Charlotte, who expects the plan to fail. “They are setting themselves up so they aren’t criticized when this thing falls apart.”
…
The fund’s lack of disclosure makes it “a necessary failure,” Bill Gross, manager of the world’s biggest bond fund at Newport Beach, California-based Pacific Investment Management Co., said in an Oct. 31 interview. “Transparency is what the Treasury and Fed are supposedly all about.”
…
Loomis Sayles & Co. declined to invest after receiving one of 16 invitations for a personal meeting last week with current Fed Chairman Ben Bernanke, said Daniel Fuss, who oversees $22 billion as chief investment officer at the Boston-based firm. The Securities Industries Financial Markets Association trade group extended the invitations, Fuss said.

“It’s so nice to get a personal invitation to go to Washington and have a one-hour visit with Ben Bernanke,” said Fuss, who decided participating wasn’t worth the risk to his firm. “Oh, boy, did I feel important for about 27 seconds, and then you smell a rat.”

Well … we shall see! But it is certain that a certain amount of forceful statements need to be made by the sponsors if there is to be any funding extended … but, on the other hand, if the idea is to stick it to the SIVs that are in trouble, how much sales will be needed? Given a choice between defaulting on their senior debt and getting a fistful of Super-Conduit term senior FRNs and capital notes, sponsors of troubled SIVs will find themselves between a rock and hard place. Naked Capitalism notes that Larry Summers writes in the Financial Times:

The priority now has to be maintaining the flow of credit. The current main policy thrust – the so-called “super conduit”, in which banks co-operate to take on the assets of troubled investment vehicles – has never been publicly explained in any detail by the US Treasury. On the information available, the “super conduit” has worrying similarities with Japanese banking practices of the 1990s that aroused criticism from American authorities for their lack of transparency, suppression of genuine market pricing of bad credits, and inhibiting effect on new lending. Perhaps there is a strong case for it, but that case has yet to be made.

Mr. Summers predicts a recession, but many disagree with him … for now:

Even bulls say that the biggest rally in government debt since 2002 has pushed yields on 10-year notes so low that they can only decline if the economy shrinks. None of the 68 economists surveyed by Bloomberg News from Nov. 1 to Nov. 8 expect the economy to contract before the end of 2008.

Prof. Stephen Cecchetti of Brandeis has been quoted here on August 27 (blaming rating agencies) and November 19 (wanting as much trading as possible on regulated exchanges) and has now commenced a four part series for VoxEU. In Part 1 he notes that:

Financial institutions have been allowed to reduce the capital that they hold by shifting assets to various legal entities that they did not own – what we now know refer to as “conduits” and “special investment vehicles” (SIV). (Every financial crisis seems to come with a new vocabulary.) Instead of owning the assets, which would have attracted a capital charge, the banks issued various guarantees to the SIVs; guarantees that did not require the banks to hold capital.

but does not suggest a solution, noting that:

under any system of rules, clever (and very highly paid) bankers will always develop strategies for holding the risks that they wanted as cheaply as they can, thereby minimizing their capital.

I have suggested that the 10% charge for a liquidity guarantee should (almost certainly) be increased; to avoid the next evasion, regulators should deem these guarantees to be in place if the bank is merely sponsoring the SIV without a guarantee; or if it has an economic interest in the survival of the SIV. Or maybe X% for an arm’s-length guarantee, double that if the bank has an economic interest.

Yes, it’s a bit like trying to plug a seive (hah!). But you do what you can.

He admits that another problem defies solution in this wicked world:

Think about the manager of a pension fund who is looking for a place to put some cash. Rules, both governmental and institutional, restrict the choices to high-rated fixed-income securities. The manager finds some AAA-rated bond that has a slightly higher yield than the rest. Because of differences in liquidity risk, for example, one bond might have a yield that is 20 or 30 basis points (0.30 or 0.30 percentage points) higher. Looking at this higher-yielding option, the pension-fund manager notices that there is a very slightly higher probability of a loss. But, on closer examination, he sees that this higher-yielding bond will only start experiencing difficulties if there is a system-wide catastrophe. Knowing that in the event of crisis, he will have bigger problems that just this one bond, the manager buys it; thereby beating the benchmark against which his performance is measured.I submit that there is no way to stop this. Managers of financial institutions will always search for the boundaries defined by the regulatory apparatus, and they will find them.

I don’t have much of a solution either! Enforcement of the Prudent Man Rule can only go so far … and if some paper defaults, it’s very difficult to show that the chance of this happening was underestimated at time of purchase. But … Prudent Man Rule will help, anyway!

Remember the Federal Home Loan Banks (FHLBs) mentioned here on October 30? It seems that FHLB Atlanta has credit policies that would be considered somewhat unusual in the private sector:

Countrywide Financial Corp. fell more than 10 percent in New York Stock Exchange trading after U.S. Senator Charles Schumer urged the regulator of the Federal Home Loan Bank system to probe cash advances to the largest U.S. mortgage lender.

Schumer said he was alarmed by the volume of advances the system’s Atlanta bank has made to Countrywide considering “the rapid deterioration” in the credit quality of some of the Calabasas, California-based company’s mortgages. Schumer expressed his concerns in a letter sent today to Federal Housing Finance Board Chairman Ronald Rosenfeld.

The Atlanta bank has made $51.1 billion in advances to Countrywide as of Sept. 30, representing 37 percent of the bank’s total outstanding advances, Schumer wrote, citing U.S. Securities and Exchange Commission filings.

In more cheerful news, Naked Capitalism reports on a hedge fund that’s hit a ten-bagger betting against sub-prime and Ed Yardeni, of Millennium Bug fame, offers up nine reasons to be thankful:

(1) The S&P 500 is up 53% since Thanksgiving 2002. The current bull market has been the third best since 1960.
(2) The 10-year Treasury yield was near 5.5% in early 2002. It is down to 4.0% this morning.
(3) The core CPI inflation rate in the US has been remarkably steady around 2%, and down from 2.6% to 1.8% on average among the 30 members of the OECD, despite the soaring price of crude oil, which is up from $27 a barrel to $99 a barrel since Thanksgiving 2002, based on West Texas Intermediate price.
(4) Notwithstanding all the nonsense about outsourcing, the unemployment rate was down to 4.7% in October vs. 5.7% five years ago as payroll employment rose 8.1 million to a record high of 138.4 million.
(5) Real disposable personal income was at a record high in September, up 16.0% since September 2002. Real per capita income is also at a record high and up 2.1% per year, on average, over the past five years.
(6) Real GDP is up 15.3% over the past five years.
(7) In the US, since the end of 2002, household net worth is up nearly 50% to a record $57.9 trillion.
(8) World exports have doubled since November 2002. The OECD world industrial production index is up 30% since then. Today, roughly three billion people around the world are aspiring and perspiring to improve their standards of living.
(9) Alan Greenspan’s book tour is over.

The New York Fed made headlines, pumping $8-billion into the term-repo market, stating:

In response to heightened pressures in money markets for funding through the year-end, the Federal Reserve Bank of New York’s Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year.

The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion. The timing and amounts of subsequent term operations spanning the year-end will be influenced by market and reserve developments.

In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC’s target rate around year-end.

The Bloomberg story seems a bit peculiar – they claim that:

Fed officials acted after the average U.S. overnight lending rate between banks exceeded their target seven of the past eight days, suggesting a reluctance to lend amid mounting subprime mortgage losses. In most years, banks face year-end pressures as they adjust their books to show ample liquidity and at the same time meet a jump in demand for cash from consumers.

While there may well be pressures, Fed Funds Data show that, in terms of averages, we’re only talking about a basis point or so. However, the maintenance period ended November 21 was clearly tighter than the period ended November 4 – and we don’t know what they had to do to keep the actual rate so well aligned with target. They may well have been influenced by the fearsome size of the TED spread:

The cost of borrowing dollars for three months rose as banks hoarded cash to cover their commitments through the end of the year. The London interbank offered rate, or Libor, for dollars rose 1 basis point to 5.05 percent, for a four-week high and the ninth straight day of gains, the British Bankers’ Association said today.

That pushed the “TED” spread, or the difference between three-month Treasury bill yields and Libor, to 1.92 percentage points from 1.82 percentage points on Nov. 23. The yield on the three-month bill fell 9 basis points to 3.12 percent.

Preferreds saw heavy volume today and violent random (as far as I can tell!) price movements based on the latest headlines. PerpetualDiscounts hit a new post-2006-6-30 low, as did SplitShares, the latter now having provided negative return since the start of these temporary indices.

There were forty other index-included $25.00-equivalent issues trading over 10,000 shares today.

Today’s phrase is “Minsky Moment” and today’s question is “Have we arrived at one?”.

Prof. Charles W. Calomiris of Columbia explains a “Minsky Moment” with:

The late Hyman Minsky developed theories of financial crises as macroeconomic events. The economic logic he focused on starts with unrealistically high asset prices and buildups of leverage based on momentum effects, myopic expectations and widespread overleveraging of consumers and firms. When asset prices collapse, the negative wealth effect on aggregate demand is amplified by a “financial accelerator”; that is, collapsing credit feeds and feeds on falling aggregate demand credit. A severe economic decline is the outcome. Many bloggers refer to this as a “Minsky moment” (see Minsky 1975 for the real thing.)

… in other words, a self-feeding collapse of the economy.

In an paper posted at VoxEU which summarizes his Not (yet) a Minsky Moment paper published by the American Enterprise Institute, he says (as one may surmise by the title) that we’re not there yet and provides eight reasons. Naked Capitalism takes violent exception to this view … so, let’s have a look at the reasons.

Calomiris: Housing prices may not be falling by as much as some economists say they are.

Smith: Real estate industry participants who have an incentive to say things are fine are instead saying they are terrible.

This is simply the old story: forecasts vs. experience. Neither player is particularly convincing.

Calomiris:Although the inventory of homes for sale has risen, housing construction activity has fallen substantially.

Smith: Per these charts, overhang is much worse than in 1988-1989, and rental vacancies are considerably higher as well. So you can’t take too much comfort from the fall off in housing starts.

I’ll award that point to Smith. Calomiris (both in the summary and the full paper) simply states that the trend in housing starts is in the proper direction; he performs no analysis of how long it will take to work of the excess inventory he acknowledges exists.

However, I would like to see more work done to relate the overhang to affordability. The latest NAHB Housing Affordability Index (MS-Excel File) shows a nationwide value of 43.1%. According to the NAHB:

“The latest HOI indicates that 43.1 percent of new and existing homes that were sold in the United States during this year’s second quarter were affordable to families earning the national median income,” said NAHB President Brian Catalde, a home builder from El Segundo, Calif.

… which is good enough, but I’m looking for something more like RBC’s Affordability Analysis, which indicates the percentage of household income taken up by ownership costs. Even this isn’t really good enough because what we are really interested in is the potential take-up of housing by those who don’t currently own houses. There must be somebody, somewhere, who’s devoted his life to the analysis of the work-out of housing inventory overhangs! Let’s find out who he is and talk to him … but I bet he’s a pretty popular guy at the moment.

Calomiris: The shock to the availability of credit has been concentrated primarily in securitisations rather than in credit markets defined more broadly (for example, in asset-backed commercial paper but not generally in the commercial paper market).

Smith Securitization has been taking market share from traditional credit intermediation (bank lending) for the last 30 years. Corporate lending, commercial and residential real estate loans, auto and credit card receivables and LBO loans are all securitized to a considerble degree. Residential real estate now depends on securitization; if there is no rebound in securitization, we will see a heap of trouble. That’s why policymakers are so keen to revive it.

Point to Calomiris. He is arguing that there is still credit around – albeit at a higher price – and (with the exception of Northern Rock) there are plenty of buyers around for commercial paper, provided the seller is willing to discount the price. Smith does not address the point raised.

Calomiris: Aggregate financial market indicators improved substantially in September and subsequently.

Smith: Events subsequent to the writing of his paper prove make this view inaccurate. The S&P 500 is on the verge of giving up its gains for the year. Bloomberg today reports that Treasuries are enjoying their longest rally in 5 years as investors seek safety.

Point to Calomiris. The fact that the S&P 500 “is on the verge of giving up its gains for the year” isn’t the most terrible thing that could happen, and hardly supports the idea that we have entered a self-feeding collapse. The point about Treasuries is stronger, but while spreads have widened, yields on mid-term bank & finance paper have more or less stayed the same.

Calomiris: nonfinancial firms are highly liquid and not overleveraged. Thus, many firms have the capacity to invest using their own resources, even if bank credit supply were to contract.

Smith: I’m not sure what his sample is. Average ratings of corporate issuers have declined, with nearly half the bonds now junk rated.

Point to Calomiris. He disclosed his sample, Federal Reserve Statistical Release Z.1, Table B.102, and Smith’s other points are irrelevant. They may be a cause for concern about the stability of the financial system, but they do not indicate that we are now in the midst of a collapse.

Calomiris: households’ wealth is at an all-time high and continues to grow. So long as employment remains strong, consumption may continue to grow despite housing sector problems.

Smith:  It won’t be for very long if housing continues on the trajectory that most anticipate, and will decline even more if the stock market follows.

Easy point to Calomiris (I should even consider giving him a bonus point). Smith is mistaking the existence of gloomy forecasts for evidence of horrible current conditions.

Calomiris: Of central importance is the healthy condition of banks.

Smith: Many are believed to be otherwise. Financial stocks hare dropped sharply this year, and large banks are now paying as much as 6% in dividends when Treasuries yield a mere 4%.

Point to Calomiris. Market prices – Smith’s idol – are down, but Tier 1 capital ratios are not showing evidence of disaster. Tough times are not a disaster. Citigroup is getting hammered – the stock is down 40% over the past year – but what’s really going on?

Deutsche Bank AG analyst Michael Mayo wrote in a report yesterday that Citigroup shares may fall to $29. He reiterated his “sell” rating and said the company may be prevented by regulators from making acquisitions because “recent risk management mishaps seem to violate” terms of an earlier agreement.

“It looks to us that recent problems with CDOs and their lack of disclosure reflect a serious risk management breakdown,” Mayo said. At $29, Citigroup would trade at eight times estimated earnings for 2008, he said.

‘Sell the stock!’ cries Mayo, ‘The earnings yield’s less than 12%!’ There may be no growth, and there may be more risks than were previously deemed to be the case, but Citigroup is still making lots of money. Dividends won’t grow much over the next few years as they rebuild their balance sheet … but this is not the end of the world. It’s a pause.

Calomiris: Banks hold much more diversified portfolios today than they used to. They are less exposed to real estate risk than in the 1980s, and much less exposed to local real estate risk, although US banks’ exposure to residential real estate has been rising since 2000

Smith: Not directly addressed.

Full point by default to Calomiris.

So I score the match 6-1 to Calomiris, with one point considered lost by both. And what’s more, I agree with him – which may, of course, have influenced my scoring. Times are tough. There’s a big indigestible mass of dubious debt on the books all over the place, but – as far as I can see – the financial system is not melting down and we are not in a depression. I’ll simply repeat what I’ve been saying for the past several months: Times are tough. Firms that have been living on the edge may find they fall off. There may even be a spectacular blow-up or two, if a financial institution finds out its risk controls aren’t what they might have wished them to be. And I most certainly would not want to be earning my living as a casual labourer in the US housing industry. But it’s a pause, nothing more.

There has been some news of interest to the carrion feeders: remember CPDOs? One of them is liquidating after a mark-to-market breached the terms of the deal. That’s the trouble with these things – it’s a great strategy, as long as there aren’t any margin calls or mark-to-markets. Moody’s assigned them a Aaa long term rating on July 6, 2007, put them under review for possible downgrade on August 21, and now they’ve defaulted. I hope UBS took its management fee in advance!

Highly leveraged muck – but, of course, when they work, they really work well. The problem with the market is, as always, stockbrokers: they’ll buy anything so long as somebody with a deep voice tells them it’s good. I cannot begin to tell you how much stuff I’ve been offered over the years that (so the salesmen say) may certainly be placed in a fixed income portfolio, but has a payoff based on something that won’t behave like a bond in the slightest. Somehow it sells. 

It’s a lot like buying an GIC from a bank with the return linked to the stock market and pretending to yourself that, because it’s a GIC, it’s really a fixed income instrument. It may be good, it may be bad – but it sure as hell ain’t a bond!

And another CDO is liquidating as the senior note-holders have decided they want their money back. I’ve had a look at the prospectus … I would like to say I can’t understand why anybody would invest in such a thing, but unfortunately, I know only too well. You can offer nice interest if you lever up to hell and gone.

The saga of Canadian ABCP continues, with Alberta Treasury Branches disclosing their write-down. They have assets of $22.5-billion, of which $1.2-billion is in ABCP and they’re taking a hit of 6.6%.

“ATB Financial has year-to-date earnings of $73 million despite absorbing a $79.6-million ABCP provision,” CEO Dave Mowat said in a release.

In more cheery news, there is a school of thought that predicts a takeover of E-Trade:

Ameritrade has an advantage as a potential buyer because it’s 40 percent owned by Toronto-Dominion Bank, Canada’s third- largest bank, Repetto said. “The bank has deep pockets and it has the ability to deal with some of the issues at E*Trade,” he said.

Exactly the kind of thing the bank should be doing … as long as they’re willing to walk away without a deal after starting negotiations.

Bond insurers, which I have discussed yesterday, took heart from the recent French bail-out and were up a lot on the day.

Still, on the lighter side, remember Flaherty and his Big Plans to Help Canadian Consumers? He was told about one of the problems at the time:

Diane Brisebois, of the Retail Council of Canada, said Flaherty should help retailers by cutting duties collected at the border.

“If you bring in sneakers from China, for example, retailers in Canada pay 18 per cent taxes. Retailers in the U.S. pay absolutely nothing,” she said.

So I thought of him today when I read this amusing snippet:

So how did the Buffalo-area mall prepare for the post-Thanksgiving shopping madness?

For one thing, Goodwill collection bins were situated at three entrances for all the clothes and shoes the crowds from the north have been ditching in restrooms and parking lots. Many shoppers have been wearing their new clothes home to avoid paying hefty taxes and duty at the border.

Good volume again in the pref market; Floaters got beat up again. It could be simply a credit thing on BAM; it could be that people are selling other BAM names to buy the perpetuals (and the derivative split share!); it could be that people are just getting out of floaters and picking on BAM to sell for other reasons. Who knows?

I continue to be utterly amazed by the yield on BNA.PR.C, which had yet another rough ride today, down 0.9444% to close at 17.83 bid, yield 8.39% to maturity. 8.39%! Basically, 11.75% interest equivalent!

I confess, I thought for a fleeting moment today that it might be inventory overhang from a barely successful underwriting … but that doesn’t seem to fit the data. They started trading January 10 and hung around at the $25.00 level until early May, when they – quite reasonably – got caught up in the downdraft. Markets were strong in the first part of the year – if the dealers had been left holding the baby, surely they would have, and could have, blown it out the door at $24.00 in, say, March.

The fund has a position in this issue and I’m getting killed on it. But how can it possibly be fairly valued at 160bp over the similar-and-parri-passu BNA.PR.B? On the bright side, looking at the price chart is highly entertaining … I’ve found a new illustration for the word “parabola”.

Such is the life of a preferred share investor …

There were thirty-five other index-included $25.00-equivalent issues trading over 10,000 shares today.